Liquidity

Question 1

Define liquidity

Answer 1

Liquidity is the ability of the business to convert current assets into cash to pay for current liabilities

Question 2

Working capital

Answer 2

Current assets − Current liabilities

Question 2

Problems that a business might face as a result of poor liquidity

Answer 2

• Unable to take advantage of cash discount given by credit suppliers as the business is unable to pay promptly
• Unable to settle its immediate debts. If this persists, the business may eventually close down.

Question 3

Why it is important for a business to be liquid

Answer 3

• To settle its immediate debts.
• To take advantage of cash discounts as the business is able to pay promptly.

Question 4

Quick ratio

Answer 4

              Total current liabilities

Question 4

Current ratio

Answer 4

Total current liabilities

Question 5

Why the quick ratio is a better indicator of liquidity than current ratio

Answer 5

Quick ratio is a more accurate measure of liquidity than current ratio as only highly liquid assets are included in the calculation. Prepayment and inventory balances are excluded as they are less able to convert into cash readily

Question 6

Ways to improve liquidity of a business

Answer 6

1. Obtain cash contributions from owner or shareholders.
2. Obtain long-term loan.
3. Sell excess non-current assets for cash.

Question 7

Why a profitable business may not be liquid

Answer 7

A profitable business could be

• selling on credit and has high sales revenue and profit but low amount of cash.
• having difficulty in collecting payment from its credit customers.